RIA s 2014 Federal Tax Review Course

Transcription

1 RIA s 2014 Federal Tax Review Course

2 RIA S 2014 Federal Tax Review Course Copyright 2013 Thomson Reuters/Tax & Accounting All Rights Reserved This course, or parts thereof, may not be reproduced in another document or manuscript in any form without the permission of the publisher. This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is sold with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional service. If legal advice or other expert assistance is required, the services of a competent professional person should be sought From a Declaration of Principles jointly adopted by a Committee of the American Bar Association and a Committee of Publishers and Associations. PRINTED IN THE UNITED STATES OF AMERICA ii

3 RIA S 2014 FEDERAL TAX REVIEW COURSE Subject Category: Taxes Level of Knowledge: Update Prerequisites: Basic Knowledge of Federal Taxation Advanced Preparation: None RIA s 2014 Federal Tax Review Course (revised November 2013) is designed to provide a general refresher course in Federal taxation to both reinforce the basics and keep practitioners up to date on the latest important changes. The course has three components: Module 1: Taxation of Individuals (8 CPE credits); Module 2: Taxation of Businesses (10 CPE credits); Module 3: Specialized Tax Issues (9 CPE credits). Course participants may take one, two, or three modules for CPE credit. Each course module provides a self-study learning experience consisting of: Instructional materials; Review questions that test for understanding of the material, with evaluative feedback given for incorrect responses and reinforcement for correct responses; and A final examination consisting of multiple choice questions, the answers to which should be recorded on the answer sheet. To obtain CPE credit, please read through the instructional materials that follow and answer the review questions as you go. Check at the end of the course to determine whether your answers to the review questions are correct, and, if not, consider the evaluative feedback included in the Solutions section of the course. When you have finished the instructional material for a module, answer the 50 examination questions for that module, and return your completed answer sheet with your evaluation form to: Thomson Reuters Tax & Accounting QZN144, QZN145, or QZN146 Self-study CPE Treasury Center Chicago, IL Each examination answer sheet will be graded, and a CPE certificate of completion will be awarded for achieving a grade of 70% or higher. The certificate will be sent to you within three to five weeks of its submission (somewhat longer during peak periods). Answer sheets CANNOT be returned. The final examination is valid only through November 30, Successful completion of each examination element should qualify you to receive continuing education credit, as outlined below and in conjunction with your CPE governing body s qualifications. Questions answered: Processing Fee: Any 1 Module (50 questions) = $ 95 Any 2 Modules (100 questions) = $140 All 3 Modules (150 questions) = $185 Additional copies of this course are available at $10.00 a copy. Call iii

4 RIA S 2014 Federal Tax Review Course This RIA course is part of the PPC self-study offerings of the Tax and Accounting business of Thomson Reuters. Practitioners Publishing Company is registered with the National Association of State Boards of Accountancy (NASBA) as a Quality Assurance Service (QAS) sponsor of continuing professional education. State boards of accountancy have final authority on acceptance of individual courses for CPE credit. Complaints regarding QAS program sponsors may be addressed to NASBA, 150 Fourth Avenue North, Suite 700, Nashville, TN Website: PPC is registered with the National Association of State Boards of Accountancy (NASBA) as a sponsor of continuing professional education on the National Registry of CPE Sponsors. State boards of accountancy have final authority on the acceptance of individual courses for CPE credit. Complaints regarding registered sponsors may be submitted to the National Registry of CPE Sponsors through its website: Registration Numbers New York Texas NASBA Registry NASBA QAS 006 iv

5 Checkpoint Learning cl.thomsonreuters.com Online Courses and Learning Management Checkpoint Learning Available for independent professionals and for firms! Checkpoint Learning provides reporting, learning reminders and prompts, CPE compliance tracking, interactive online courses, downloadable self-study courses, online grading, and much more! Select from hundreds of online and downloadable courses on auditing, tax, management, Yellow Book, and staff training topics available individually or via a subscription package: Checkpoint Learning Premier CPE Package. Our single-price comprehensive subscriptions are an industry first, bringing all of your CPE needs together: online and print-based self-study courses; webinars; CPE tracking and compliance monitoring; plus huge discounts on live seminars and conferences! The Premier CPE Package is suited to both independent professionals and firms of all sizes. Also available: Compliance and Professional CPE packages affordable options to manage your CPE. MicroMash on Checkpoint Learning A trusted provider of technology-based CPE and training for over 20 years to accounting firms, corporate teams, sole practitioners and government agencies. Choose from over 175 courses on hot topics that will help you stay on top of your field. PASS Online on Checkpoint Learning A CPE provider since 1990, PASS Online offers more than 200 courses covering a variety of accounting and tax topics, including industry-leading state ethics training courses by state and by area of specialty. Live Seminars & Conferences Gear Up Seminars and Conferences A leading provider of tax and accounting education for more than 40 years, Gear Up events are available nationwide. Gear Up is an IRS-approved provider of continuing education. Seminars: Half-day to two-day seminars in most states! Select from our 1040 and Business Entities seminars, plus dozens of specialty titles. Conferences: Our week-long CPE conferences are held at exciting vacation destinations! 2013 conferences include Jackpot in Las Vegas (May 20 25), Citrus Week in Orlando (June 17 20), Windy City Week in Chicago (July 22 27), Royal Flush in Las Vegas (December 2 7), and Magic Week in Orlando (December 17 21). AuditWatch Public Seminars AuditWatch, the audit profession s premier training and consulting firm and recognized leader in audit productivity, offers specialized auditing seminars in 15 locations nationwide. Our 2013 seminar line-up includes AuditWatch University core audit staff training, Levels 1-6; TaxWatch University core tax staff training, Levels 1-4; and Yellow Book University. CFNSERT13

6 In-House Training and Consulting PPC In-House Seminars PPC offers on-site customized training on over 50 accounting and auditing, management, staff training, tax and Yellow Book topics. This learning experience is custom-tailored to meet your needs, is taught by highly rated instructors and features current, relevant course content; and at approximately $15 per credit hour, in-house training is very affordable! Practitioners Monthly Video Digest This monthly CPE product is a convenient and cost-effective way for firms to provide timely, leading-edge in-house training. Every month (excluding February and March) your firm will receive access to a training module via our online delivery system. The training module includes a high-quality instructional video and related course materials including an instructor s guide and participant materials. Materials can be downloaded and the module can be launched at your convenience. Members of your firm will meet monthly, watch the video featuring leading experts addressing new and emerging issues, and participate in related discussions. Checkpoint Learning Webinars You ll find webinars on the latest developments in tax, accounting, auditing, finance and more all you need is a high-speed internet connection! With over 40 events to choose from each month--including full-day webinars offering up to 8 CPE credits!--you ll always find topics to fit your schedule and learning needs. AuditWatch AuditWatch has an intense focus on serving the audit and accounting profession with leading experts to train and consult with firms that provide auditing services. Our integrated development curriculum for audit professionals and CPA firms, audit process consulting, and audit technology services makes AuditWatch the recognized leader in audit productivity. Self-Study Courses PPC Self-Study Learn with the company that provides the industry-leading PPC Guides convenient self-study courses are available on a variety of accounting & auditing and tax topics. Easily access many print-based self-study courses as downloadable PDFs and complete your CPE exams online for immediate results, now directly through the new Checkpoint Learning platform! Gear Up Self-Study A leading provider of tax and accounting education for more than 40 years, Gear Up offers print-based self-study courses based on our popular live seminars plus additional stand-alone specialty topics. Most live seminar topics can be supplemented with video and audio materials to provide you with the feel of an instructor-led seminar in your home or office learn on your schedule! Quickfinder Self-Study Quickfinder s trusted content combined with Gear Up s history as a leader in tax & accounting professional education available as direct downloads combined with online grading on Checkpoint Learning. RIA Self-Study RIA s must-have Federal Tax Review course is a general refresher in federal taxation that will reinforce basic tax law interpretations and keep you up-to-date on the most important tax changes. Download RIA self-study course materials and use online grading for immediate results on the Checkpoint Learning platform. TAX & ACCOUNTING cl.thomsonreuters.com CFNSERT13

7 RIA S 2014 FEDERAL TAX REVIEW COURSE MODULE 1: TAXATION OF INDIVIDUALS I. Overview of Individual Income Tax... 1 II. Gross Income... 4 III. Sales and Exchanges IV. Deductions V. Tax Credits VI. Withholding and Estimated Taxes VII. Tax Returns and Payment of Taxes VIII. Individual Alternative Minimum Tax Solutions to Module 1 Review Questions Glossary Index Module 1 Final Exam Questions MODULE 2: TAXATION OF BUSINESSES Introduction I. Forms of Business Organizations II. Tax Accounting III. Business Expenses IV. Depreciation and Amortization V. Business Tax Credits VI. Taxation of C Corporations VII. Corporate Transactions VIII. S Corporations IX. Partnerships Solutions to Module 2 Review Questions Glossary Index Module 2 Final Exam Questions MODULE 3: SPECIALIZED TAX ISSUES Introduction I. Taxation of Trusts, Estates, and Decedents II. Exempt Organizations III. Taxation of Farming IV. Employee Benefit Plans V. Employee Retirement Plans VI. Estate and Gift Tax VII. Dealing with the IRS Solutions to Module 3 Review Questions Glossary Index Module 3 Final Exam Questions EXAMINATION FOR CPE CREDIT ANSWER SHEETS SELF-STUDY COURSE EVALUATIONS v

8 vi

9 Module 1 Introduction INTRODUCTION RIA s 2014 Federal Tax Review Course consists of three interactive self-study CPE course modules. There is a charge for grading and processing your answer sheet for each course module. To obtain credit, your Examination for CPE Credit Answer Sheet(s) must be submitted for grading by November 30, Taking the Course Each course module addresses an aspect of Federal taxation. You are asked to read the material and, during the course, test your comprehension of each of the learning objectives by answering self-study quiz questions. After answering each quiz question, you can evaluate your progress by comparing your answer to both the correct and incorrect answers and the reason for each. References are also cited so you can go back to the text where the topic is discussed in detail. Once you are satisfied you understand the material, answer the examination questions which follow each course module. You may either record your answer choices on the printed Examination for CPE Credit Answer Sheet or by logging on to our Online Grading System. Qualifying Credit Hours QAS or Registry This RIA self-study course is part of Thomson Reuters Tax & Accounting, Learning Solutions, self-study offerings. PPC is registered with the National Association of State Boards of Accountancy as a sponsor of continuing professional education on the National Registry of CPE Sponsors (Registry) and as a Quality Assurance Service (QAS) sponsor. Part of the requirements for both Registry and QAS membership include conforming to the Statement on Standards of Continuing Professional Education (CPE) Programs (the standards). The standards were developed jointly by NASBA and the AICPA. As of this date, not all boards of public accountancy have adopted the standards. Each course is designed to comply with the standards. For states adopting the standards, recognizing QAS hours or Registry hours, credit hours are measured in 50-minute contact hours. Some states, however, require 100-minute contact hours for self study. Your state licensing board has final authority on accepting Registry hours, QAS hours, or hours under the standards. Check with the state board of accountancy in the state in which you are licensed to determine if they participate in the QAS program or have adopted the standards and allow QAS CPE credit hours. Alternatively, you may visit the NASBA website at for a listing of states that accept QAS hours or have adopted the standards. Credit hours for CPE courses vary in length. Credit hours for each course are listed on the Overview page before each course. CPE requirements are established by each state. You should check with your state board of accountancy to determine the acceptability of this course. We have been informed by the North Carolina State Board of Certified Public Accountant Examiners and the Mississippi State Board of Public Accountancy that they will not allow credit for courses included in books or periodicals. Obtaining CPE Credit After completing each course module, you can receive CPE credit by logging on to our Online Grading System at cl.thomsonreuters.com. Click the purchase link and a list of exams will appear. You may search for the exam using the acronyms QZN144, QZN145, or QZN146. The correct acronym is listed at the top of the answer sheet for each course module. Payment for the exam is accepted over a secure site using your credit card. For further instructions regarding the Online Grading System, please refer to the Test Instructions located at the beginning of each course module examination. If you prefer, you may continue to mail your completed Examination for CPE Credit Answer Sheet to Thomson Reuters Tax & Accounting for grading. The answer sheet is identified with the course acronym. Please ensure you use the correct answer sheet. Payment (by check or credit card) must accompany each answer sheet submitted. We cannot process answer sheets that do not include payment. The examination contains instructions for obtaining CPE credit. A certificate documenting the CPE credits will be issued for each examination score of 70% or higher. Please take a few minutes to complete the Course Evaluation and return it to us so that we can provide you with the best possible CPE. vii

10 RIA S 2014 Federal Tax Review Course If more than one person wants to complete this self-study course, each person should complete a separate Examination for CPE Credit Answer Sheet. Payment must accompany each answer sheet submitted. We would also appreciate a separate Course Evaluation from each person who completes an examination. Express Grading: An express grading service is available for an additional $24.95 per examination. Course results will be faxed to you by 5 p.m. CST of the business day following receipt of your Examination for CPE Credit Answer Sheet. Expedited grading requests will be accepted by fax only if accompanied with credit card information. Obtaining EA and RTRP Credit To receive EA and RTRP credit, you must provide your PTIN to Thomson Reuters in one of two ways. Log on to cl.thomsonreuters.com, select the Settings tab, and then Edit My Membership Information. Select IRS PTIN (EA and RTRP) and input your PTIN. Alternatively, if you are submitting your exam for print grading, write your PTIN in the space provided on your answer sheet. Retaining CPE Records For all scores of 70% or higher, you will receive a Certificate of Completion. You should retain it and a copy of these materials for at least five years. In-firm Training PPC also offers a number of in-firm training classes that provide up to eight hours of PCE credit. Please call our Sales Department at (800) for more information. viii

11 Module 1 Overview RIA s 2014 Federal Tax Review Course OVERVIEW COURSE DESCRIPTION: RIA s 2014 Federal Tax Review Course Module 1 is a general refresher course in Federal taxation of individuals. It is designed to reinforce basic tax law interpretations while keeping practitioners up to date on the latest and most important changes. The course has been updated to reflect the latest in tax legislation through the American Taxpayer Act of PUBLICATION/REVISION DATE: RECOMMENDED FOR: PREREQUISITE/ADVANCE PREPARATION: CPE CREDIT: November 2013 Users of RIA s Federal Tax Handbook Basic knowledge of federal taxation 8 QAS Hours, 8 Registry Hours Check with the state board of accountancy in the state in which you are licensed to determine if they participate in the QAS program and allow QAS CPE credit hours. This course is based on one CPE credit for each 50 minutes of study time in accordance with standards issued by NASBA. Note that some states require 100- minute contact hours for self-study. You may also visit the NASBA website at for a listing of states that accept QAS hours. Enrolled Agents: This CPE course is designed to enhance professional knowledge for Enrolled Agents. Gear Up is a qualified CPE Sponsor for Enrolled Agents as required by Circular 230 Section 10.6(g)(2)(ii). CTEC CREDIT: EA CREDIT: RTRP CREDIT: FIELD OF STUDY: 8 Federal Tax Update Hours 8 Federal Tax Law/Tax Related Matters Hours 8 Federal Update Hours Taxes EXPIRATION DATE: Postmarked by November 30, 2014 KNOWLEDGE LEVEL: Update ix

12 RIA s 2014 Federal Tax Review Course LEARNING OBJECTIVES After completing Course Module 1, you should be able to: Identify and compute key tax items, such as gross income, deductions from gross income, itemized deductions, and taxable income; and apply the special rules for determining the tax on unearned income of young individuals. Describe the tax treatment of compensation and investment income and identify when employee benefits are included in income and when they are excluded. Recognize income from other sources, including self-employment, insurance and annuities, gifts and inheritances, prizes and awards, insurance and damages, debt discharges, and expense reimbursements. Determine the basis of property and when gain or loss is recognized if the property is sold or exchanged. Discuss capital gains and losses and the netting process. Discuss standard and itemized deductions, the limitations associated with deductions, and exemptions and dependents under the current tax Code. Determine the tax benefits related to retirement contributions, medical and health savings accounts, and education expenses. Distinguish between refundable and nonrefundable credits. Apply the eligibility requirements for, and limitations on, personal tax credits. Demonstrate an understanding of tax withholding requirements. Compute required installments of estimated taxes. Determine a taxpayer s tax filing status and tax filing and payment responsibilities. List the special liability rules and relief provisions for joint return filers. Identify basic structural and computational elements of the alternative minimum tax. x

13 Module 1 Overview TO COMPLETE THIS LEARNING PROCESS: Send your completed Examination for CPE Credit Answer Sheet(s), Course Evaluation(s), and payment to: Thomson Reuters Tax & Accounting QZN144 Self-study CPE Treasury Center Chicago, IL See the test instructions for more information. ADMINISTRATIVE POLICIES: For information regarding refunds and compliant resolutions, dial (800) , select the option for Customer Service, and your questions or concerns will be promptly addressed. xi

14 RIA s 2014 Federal Tax Review Course RIA S 2014 FEDERAL TAX REVIEW COURSE MODULE 1: TAXATION OF INDIVIDUALS I. Overview of Individual Income Tax... 1 II. Gross Income... 4 III. Sales and Exchanges IV. Deductions V. Tax Credits VI. Withholding and Estimated Taxes VII. Tax Returns and Payment of Taxes VIII. Individual Alternative Minimum Tax Solutions to Module 1 Review Questions Glossary Index Module 1 Final Exam Questions xii

15 MODULE 1: TAXATION OF INDIVIDUALS I. Overview of Individual Income Tax Learning Objective After completing this section, you should be able to: Identify and compute key tax items, such as gross income, deductions from gross income, itemized deductions, and taxable income; and apply the special rules for determining the tax on unearned income of young individuals. The Internal Revenue Code (IRC) imposes a tax liability on the taxable income of individuals. (Code Sec. 1). This income tax liability is increased for some individuals by other taxes (e.g., the selfemployment tax and the alternative minimum tax), and is reduced by certain credits. A. How Income Tax on Individuals Is Computed To compute taxable income, an individual taxpayer first must compute gross income generally all income from all sources. (Code Sec. 61) From gross income, the taxpayer subtracts certain deductions to reach adjusted gross income (AGI). (Code Sec. 62) Finally, taxpayers reduce their AGI by either (1) itemizing certain deductions and claiming personal exemptions or (2) claiming the standard deduction and personal exemptions. (Code Sec. 63(a); Code Sec. 63(b)) The result is a taxpayer s taxable income. The following items can be deducted from gross income to arrive at AGI: (Code Sec. 62) Trade or business expenses (other than unreimbursed employee business expenses); Self-employed medical insurance premiums; Moving expenses; 50% of self-employment tax; Amortization of reforestation expenditures; Amounts forfeited to a bank or savings institution for premature withdrawal of funds from a deposit account; Alimony and separate maintenance payments; Employee expenses that are reimbursed by the employer or a third party under an accountable reimbursement arrangement; Employee business expenses of certain performing artists and of state and local government employees compensated on a fee basis; Jury duty pay remitted to an employer; Contributions to Keogh or Simplified Employee Pension (SEP) plans for the self-employed; Contributions to individual retirement accounts (IRAs); Contributions to health savings accounts (HSAs); Contributions to Archer medical savings accounts (MSAs); The total taxable amount of a lump-sum distribution from a retirement plan to a participant who reached age 50 before 1986; Deductions in connection with property held for the production of rents or royalties; 1

16 RIA s 2014 Federal Tax Review Course Depreciation and depletion deductions of a life tenant or an income beneficiary of a trust, or of an heir, legatee or devisee of an estate; Losses from the sale or exchange of property; Repayment of supplemental unemployment compensation benefits; Certain foreign housing costs by individuals having income earned abroad; Deduction for interest on qualified education loans; Payments for deductible higher education expenses (before 2014); Up to $250 of qualifying expenses of educators (before 2014); Certain unreimbursed travel expenses of National Guard and Reserve members; and Attorney fees and court costs of civil rights suits and whistleblower awards. Caution: Expired or expiring provisions may be extended by Congress. Itemized deductions are all allowable deductions except those subtracted from gross income in arriving at adjusted gross income (above), and except the deductions for personal exemptions. (Code Sec. 63(d)) Itemized deductions include nonbusiness deductions, such as those for medical expenses, charitable contributions, state and local income taxes, and home mortgage interest, plus employee business expenses. Review Question 1 Which of the following is not claimed as a deduction from gross income to arrive at AGI? a. Interest on a qualified education loan. b. Home mortgage interest. c. Contribution to an IRA. The annual income tax liability of an individual on taxable income is computed by using either the tax rate schedules or (when taxable income is less than $100,000) the tax tables issued by the IRS. There are tax rate schedules for: Single persons (not married at year s end), including certain marrieds living apart. These rates are more favorable than those for marrieds filing separate returns, but less favorable than head of household and (generally) joint return rates. Married couples filing joint returns, and certain widows and widowers who qualify as surviving spouses. These are often the most favorable rates. Heads of household. These rates are more favorable than those for single persons. Married persons filing separate returns the least favorable rates. (Code Sec. 1) Review Question 2 An individual qualifying as a surviving spouse uses the same tax rates as: a. Single individuals. b. Married taxpayers filing separately. c. Married taxpayers filing jointly. d. Heads of households. For tax years beginning on or after January 1, 2013, there are seven tax brackets with rates of 10%, 15%, 25%, 28%, 33%, 35%, and 39.6%. A taxpayer s tax liability as determined above may be increased by certain taxes (e.g., selfemployment tax; see VII.G.) and reduced by certain tax credits (see V.). 2

17 Federal Tax Review Course Module 1 B. Tax on Unearned Income of Young Individuals (Kiddie Tax) A young individual may be required to pay tax at his or her parents highest marginal rate on the individual s unearned income over $2,000 for 2013 if that tax is higher than what the individual would otherwise pay on it. The parents can instead elect to include on their own return the individual s gross income in excess of $2,000. This increased tax for younger individuals has traditionally been referred to as the kiddie tax. For tax years beginning after May 25, 2007, the kiddie tax applies to an individual who: (1) is either (a) under age 18 or age 18 at the close of the tax year or (b) age 19 through 23 at the close of the tax year and a full-time student; (2) has earned income for the tax year that doesn t exceed one-half of his or her support for the tax year; (3) has at least one parent alive at the close of the year; and (4) does not file a joint return for the tax year. The child pays a tax equal to the greater of: the sum of (a) the tax that would be imposed if the taxable income of the child for the tax year were reduced by the net unearned income of the child, plus (b) the child s share of the allocable parental tax (see below) (Code Sec. 1(g)(1)(B)), or the tax imposed on the child without regard to (1), above (Code Sec. 1(g)(1)(A)), that is, the tax imposed on the child as a single person. The allocable parental tax is the excess of: (1) the tax that would be imposed by these rules on the parent s taxable income if that income included the net unearned income of all children of the parent to whom these rules apply, over (2) the tax imposed on the parent without regard to these rules. The child s share of the allocable parental tax equals the amount that bears the same ratio to the total allocable parental tax as the child s net unearned income bears to the aggregate net unearned income of all children of the parent to whom this tax applies. (Code Sec. 1(g)(3)(B)) Net unearned income is adjusted gross unearned income reduced by the sum of the amounts determined under (1), (2) and (3), below. (Code Sec. 1(g)(4)(A); Reg 1.1(i)-1T, Q&A-6) These are: the amount allowable as a standard deduction for dependents, specifically $1,000 in 2013 (RIA estimate); the greater of (a) the amount in (1), above, or (b) the amount of the itemized deductions which are directly connected with the production of the unearned income if the child itemizes deductions; adjustments to income attributable to the unearned (investment) income, such as the penalty on early withdrawal of savings. However, net unearned income for any tax year can t exceed the child s taxable income for the year. (Code Sec. 1(g)(4)(B)) As a result of the above rules, for example, the child s first $1,000 of 2013 unearned income isn t taxed at all, the next $1,000 of unearned income is taxed at the child s tax rate, and the remainder of the child s unearned income is taxed at the parent s marginal rate. Review Question 3 An individual subject to the kiddie tax has $2,000 of earned income and $2,600 of unearned income for The individual is in the 10% tax bracket and the marginal tax rate of the individual s parents is 35% for The individual must pay tax at the parent s marginal rate on: a. $4,600. b. $2,600. c. $1,600. d. $600. 3

18 RIA s 2014 Federal Tax Review Course II. Gross Income Learning Objectives After completing this section, you should be able to: Describe the tax treatment of compensation and investment income and identify when employee benefits are included in income and when they are excluded. Recognize income from other sources, including self-employment, insurance and annuities, gifts and inheritances, prizes and awards, insurance and damages, debt discharges, and expense reimbursements. Gross income consists of all income, from all sources, such as compensation for services, business income, interest, rents, dividends and gains from the sale of property. Only items specifically exempt may be excluded. The person who earns and is entitled to receive income is taxed on it. He or she can t avoid tax on it by assigning it to another. But if a taxpayer assigns or transfers income-producing property before the income is earned, the assignee will be taxed on the income. As a general rule, persons holding property as joint tenants (with rights of survivorship) each report one-half of the income from the property. A joint tenancy should be distinguished from a tenancy in common (without survivorship rights), in which each of the tenants-in-common is taxed on the income from his or her share. Federal tax law recognizes the principle of community income in community property states (AZ, CA, ID, LA, NV, NM, TX, WA and WI) or countries, which treats half of community income and expenses as belonging to each spouse. Community income is all the income from community property (including business property) and salaries, etc., for the services of either or both spouses. Income from separate property during marriage is community income only in ID, LA, TX and WI. The IRS has officially acknowledged that registered domestic partners (RDPs) in the states of Nevada, Washington and California, as well as same-sex spouses in California, have full community property rights under state law that are recognized for federal tax purposes. (Clarification to Publication 555 (Rev ), Community Property 01-Mar See also Questions and Answers for Registered Domestic Partners in Community Property States and Same-Sex Spouses in California) Note: Since the publication of the IRS guidance, the state of Washington approved same-sex marriage effective December 6, The law provides for automatic conversion of domestic partnerships not involving a member age 62 or older into civil marriages unless dissolved within two years of the law s effective date. When income must be reported depends on a taxpayer s method of accounting. A taxpayer may use one method of accounting to keep personal books and another to keep the books for his or her trade or business. But the two must be strictly separated. (Reg (c)(1)(iv)(b)) Various methods of tax accounting are permissible. For example, under the accrual method, income is reported in the tax year in which the right to the income becomes fixed and the amount of the income can be determined with reasonable accuracy. Under the cash method, gross income includes cash or property actually or constructively received during the tax year. Most individuals report their personal income using the cash method of accounting. A. Compensation Gross income includes compensation for services including: wages, salaries, fees, tips, salespersons commissions (including commissions on sales to self or family), percentage of profits paid as compensation, commissions on insurance premiums, bonuses, termination or severance pay, golden parachute payments, jury duty fees and fringe benefits not excluded by statute. Pension or retirement allowances to employees generally are taxable to the recipient. Although gifts are generally excluded from the recipient s gross income (see below), a transfer by or for an employer to or for the benefit of an employee can t be excluded as a gift. (Code Sec. 102(c)(1)) 4

19 Federal Tax Review Course Module 1 If services rendered by the taxpayer are paid for in property or services rather than money, the fair market value (FMV) of the property or services must be included in income. For example, if a vacation trip is awarded to a salesperson as a prize, the FMV of the trip is income. Where a price has been specified for the services being rendered, that price is considered the FMV of the property or services received if there s no evidence showing a different value. (Code Sec. 83; Reg (d)) Notes and other evidences of indebtedness received in payment for services or in settlement of a claim for compensation are taxable as compensation in the amount of their fair market value when received. When a taxpayer receives as compensation a non-interest-bearing note regarded as good for its face value at maturity, he treats as income its fair discounted value computed at the prevailing rate. As note payments are received, he includes in income that portion of each payment representing the proportionate part of the discount originally taken on the entire note. (Reg (d)(4)) Where an employer pays the debts or personal expenses of an employee, or reimburses the employee s payment, the employee must include the employer s payment or reimbursement in his or her income. There are some exceptions, such as medical expense reimbursements (see II.B.1.). The amount of wages, salaries, tips, etc., that s includible in income is shown on a Form W-2 issued by the employer and is reported on the employee s return. Review Question 4 Which of the following is not treated as compensation includible in an employee s gross income? a. Tips from customers. b. Commissions on sales to family members. c. A $100 gift received from the employer as a thank you for exceptional services. d. Medical expense reimbursements. 1. Restricted Property A person receiving a beneficial interest in stock or other property for his or her services has compensation income equal to the value of that property at the time of receipt. But if the interest in the property is subject to substantial risk of forfeiture (is restricted ) and can t be transferred free of that risk, then income is deferred until the interest in the property either: (1) is no longer subject to that risk, or (2) becomes transferable free of the risk, whichever occurs earlier. (Code Sec. 83) But the employee (or other owner of the property) has income if he sells or disposes of the property before (1) or (2). (Code Sec. 83(a)) The amount included in income (in the year in which (1) or (2) above occurs) is the excess of: the fair market value of the property in that year (figured without regard to restrictions other than those that by their terms will never lapse), over the amount, if any, paid for the property. (Code Sec. 83(a)) A substantial risk of forfeiture exists if a person s rights to full enjoyment of the property are conditioned, directly or indirectly, upon the future performance (or refraining from performance) of substantial services by any individual. (Code Sec. 83(c)(1); Reg (c)(1)) An employee who receives restricted stock or other property may elect to recognize the income immediately instead of deferring it. (Code Sec. 83(b)(1)). 2. Incentive Stock Options If an employer corporation grants an employee an option to buy stock in the corporation and certain requirements are met, then the option is considered an incentive stock option (ISO). There are no regular income tax consequences when an ISO is granted or exercised; the employee has capital gain when the stock is sold at a gain. (Code Sec. 421(a)) To qualify for this favorable tax treatment, stock acquired through the exercise of an ISO can t be disposed of within two years after the option is granted or one year after the stock is transferred to the employee. (Code Sec. 422(a)(1)) Also, for the entire time from the date an ISO is granted until three months (one year in case of total and permanent disability) before its exercise, the option holder must be an employee of the option grantor. (Code Sec. 422(a)(2)) 5

20 RIA s 2014 Federal Tax Review Course 3. Nonstatutory Stock Options If an employee receives a stock option from an employer corporation that does not meet ISO requirements (above), then the employee has compensation income. (Code Sec. 83) If the option has a readily ascertainable fair market value (FMV) at grant, it s subject to the restricted property rules (see II.A.1.) when the option is granted. (Code Sec. 83; Reg (a)) An option ordinarily has a readily ascertainable FMV only if it (or a substantially identical option) is actively traded on an established market. If not so traded, it has value only if certain conditions exist. (Reg (b)) If the option doesn t have a readily ascertainable FMV when granted, the employee doesn t realize compensation until the optioned stock is transferred at exercise. The amount of compensation is the FMV of the stock at transfer less any amount paid for the stock. (Reg (a)) 4. Below-market Loans An employee who receives a below-market compensation-related loan (except certain de minimis loans) generally recognizes compensation income. The amount of the income is equal to: on a compensation-related demand loan, the forgone interest (interest at the IRS-specified applicable federal rate over actual interest payable), and on any other compensation-related loan, the excess of the amount borrowed over the present value of all payments required to be made under the terms of the loan. (Code Sec. 7872(a)(1); Code Sec. 7872(b)(1)) B. Employee Benefits A benefit provided to any person in connection with the performance of services is generally treated as compensation for those services. Unless it s specifically excluded, the benefit is includible in the gross income of the person performing the services, even if it s furnished to someone else. Some employee benefits are excludable from an employee s income if the benefit plan meets certain requirements. For a discussion of these plan requirements, see Module 3, Specialized Tax Issues. 1. Health and Accident Plans An employee can exclude from gross income amounts received from his or her employer, directly or indirectly, as reimbursement for expenses for the medical care of the employee and his or her spouse and dependents. However, reimbursement is includible in the employee s income to the extent it exceeds medical expenses or it s attributable to medical expense deductions taken in a previous year. (Code Sec. 105(b); Reg ) Special rules apply to self-insured medical reimbursement plans that discriminate in favor of highly compensated employees, see Module 3, Specialized Tax Issues. An employee also excludes from gross income the cost (i.e., premiums paid) of employer-provided coverage under an accident or health plan. (Code Sec. 106) However, if the employer-provided policy, trust, etc., provides other benefits, only the portion of the employer contributions for the accident and health coverage is excludable. (Reg ) Traditionally, the exclusions from gross income for employer-provided accident and health coverage and medical expense reimbursements have applied only to qualifying child and qualifying relative dependents as defined in Code Section 152 (i.e., children under age 19 or children under age 24 who are full-time students and other individuals who meet gross income and support tests). However, a provision added by the 2010 Health Care Act (P.L as amended by P.L ) requires health plans that provide dependent coverage to make that coverage available to an employee s adult child until the child reaches age 26. (Code Sec. 9815). A corresponding change extends the exclusion for reimbursements for medical care to any child who has not reached age 27 as of the end of the tax year. (Code Sec. 105(b)) This change also applies to the exclusion for employer-provided coverage under an accident or health plan for injuries or sickness for such child. (Notice , I.R.B. 682) 6

21 Federal Tax Review Course Module 1 Lump sum or installment amounts received under an employer s plan as payment for permanent loss or loss of use of a member or function of the body, or permanent disfigurement, of the employee, his spouse or his dependent are tax-free, but only if the payment is based on the nature of the injury without regard to the period the employee is absent from work. (Code Sec. 105(c)) Amounts received under a workers compensation act or similar law for personal injuries or sickness are excludable from the employee s (or survivor s) income. But worker s compensation is includible in income to the extent it s attributable to medical expense deductions taken in an earlier year. (Code Sec. 104(a)(1); Reg (b)) 2. Qualified Retirement Plans Employer contributions to a qualified retirement plan are (within limits) excludable from an employee s income. Distributions from a qualified retirement plan (reported to recipients on Form 1099-R) generally are taxed to the employee in the year distributed or otherwise made available to the employee. (Code Sec. 402(a); Reg 1.402(a)-1(a)). A retirement plan distribution is not taxable when received if it is an eligible rollover distribution and the employee then transfers the benefit to an eligible retirement plan. (Code Sec. 402(c)(1)) A distribution must be rolled over within 60 days after receipt to be tax-free, but IRS may waive the 60-day rollover period for equitable reasons, including cases of casualty, disaster, or other events beyond an individual s control. (Code Sec. 402(c)(3); Code Sec. 408(d)(3)) For a discussion of qualified retirement plans, see Module 3, Specialized Tax Issues. 3. Meals and Lodging Meals or lodging (including utilities) furnished to an employee and his family (spouse and dependents) is nontaxable to the employee if (Code Sec. 119): meals and lodging are furnished by or on behalf of the employer for the convenience of the employer (e.g., meals supplied because eating places near work are scarce, or because employees must for valid business reasons remain on-premises until their shifts end) (Reg (a)(2)), and in the case of meals, they are furnished on the employer s business premises, or in the case of lodging, the employee is required to accept the lodging as a condition of his employment (i.e., to properly perform his duties). (Reg (b)) The value (not the cost) of meals or lodging that fails to meet these tests generally is income to the employee. (Reg (d)(3); Reg (a)(1)) 4. Split-dollar Life Insurance Under a split-dollar insurance arrangement, the employer pays part of the premium for a life insurance policy on the life of the employee (to the extent of the annual increase in cash surrender value) and the employee pays the rest. Out of the insurance proceeds, the employer gets either the cash surrender value or the amount it paid; the employee can designate the beneficiary of the balance. For arrangements entered into (or materially modified) after September 17, 2003, there are two mutually exclusive regimes for taxing split-dollar life insurance arrangements. Both the policy owner and the nonowner account for all amounts under the split-dollar life insurance arrangement under one of the following: Economic benefit regime the policy owner is treated as providing economic benefits to the nonowner. This regime governs the taxation of what are known as endorsement split-dollar arrangements (e.g., employer owns the policy and employee s rights are derived from the employer s endorsement in the contract of those rights to him). This regime automatically applies if the arrangement is entered into in connection with the performance of services, and the employee or other service provider is not the contract owner. (Reg ) 7

22 RIA s 2014 Federal Tax Review Course Loan regime the non-owner of the life insurance contract is treated as loaning premium payments to the contract owner. The loan regime governs what are known as collateral assignment split-dollar life insurance arrangements (e.g., employee owns the policy, which is used as collateral for employer s right to recover the premiums it pays). (Reg ) Substantially different tax consequences result depending on which party owns the life insurance contract. The employer is treated as the owner of a split-dollar life insurance contract if the only economic benefit that the employee has under the arrangement is current life insurance protection. (Reg (c)(1)) In a split-dollar life insurance arrangement taxed under the economic benefit regime, the policy owner (e.g., employer) is treated as providing economic benefits to the non-owner (e.g., employee), and those benefits have to be accounted for fully and consistently by both the owner and the non-owner. The value of the economic benefits, less any consideration paid by the non-owner, is treated as transferred from the owner to the non-owner. Thus, where an employer is the owner and the employee the non-owner, the economic benefits are treated as compensation. (Reg (d)(1)) A payment made under a split-dollar life insurance arrangement is a split-dollar loan, and the policy owner and non-owner are treated, respectively, as borrower and lender, if: the payment is made directly or indirectly by the non-owner to the owner; the payment either is a loan under general tax law principles or if a reasonable person would expect the payment to be repaid in full to the non-owner; and repayment is to be made from, or secured by, the policy s death benefit or cash surrender value, or both. (Reg (a)(2)) 5. Group Term Life Insurance An employee isn t taxed on premiums paid by the employer for insurance covering the employee s life under a qualifying group-term life insurance policy if the employee s total coverage under all such plans of all his employers doesn t exceed $50,000. If total coverage does exceed $50,000, the employee is taxed on the cost of coverage over $50,000 minus the amount he paid. (Code Sec. 79(a)) The employer must compute the cost of taxable group-term coverage and notify the employee on Form W-2 of the amount included in his or her income. The cost of group-term life insurance is determined on the basis of uniform premiums (computed on the basis of five-year age brackets) prescribed by IRS. (Code Sec. 79(c)) Review Question 5 A taxpayer who receives $60,000 of employer-provided group term life insurance coverage must include the cost of of insurance in gross income. a. $0. b. $10,000. c. $50,000. d. $60, Dependent Care Assistance Payments incurred by an employer for dependent care assistance under a qualifying plan are excluded from an employee s gross income. (Code Sec. 129(a)(1)) The amount an employee can exclude (computed on Form 2441 with Form 1040 or Form 1040A) can t exceed the employee s earned income (excluding employer dependent care assistance payments) or, for married employees, the earned income of the lower earning spouse. (Code Sec. 129(b)) The aggregate exclusion is further limited to $5,000 ($2,500 for a married individual filing separately). (Code Sec. 129(a)(2)(A)) Review Question 6 An employee receives $6,000 of dependent care assistance from his employer s qualifying plan. On the joint return he files with his wife, he reports $30,000 of earnings from his job and $4,000 of earnings from his wife s part-time employment. How much of the dependent care assistance is taxable to the employee? a. $0. b. $1,000. c. $2,000. d. $6,000. 8

23 Federal Tax Review Course Module 1 7. Education Assistance An employee s gross income doesn t include amounts paid or expenses incurred by the employer for educational assistance to the employee under an employer s qualified educational assistance program. (Code Sec. 127(a)(1)) The maximum amount of educational assistance that an employee can receive tax free under an educational assistance plan during any calendar year is $5,250. The education received need not be job-related. (Code Sec. 127(a)(2)) The exclusion does not cover meals, lodging, and transportation (Code Sec. 127(c)(7)). Expenses paid by an employer for education or training provided to the employee that aren t excludable under this provision can only be excluded from income if they qualify as a working condition fringe benefit (see II.B.9.) (Code Sec. 132(j)(8)). 8. Adoption Assistance An employee may exclude amounts paid or expenses incurred by his employer for qualified adoption expenses connected with the employee s adoption of a child, if the amounts are furnished under an adoption assistance program in existence (and known to the employee) before the expenses are incurred. For 2013, the maximum exclusion for employer-provided adoption assistance is $12,970 per child (for both non-special needs and special needs adoptions). (Code Sec. 137) The dollar limit applies to the adoption of each child and is cumulative over all tax years (rather than an annual limit). In the case of an adoption of a child with special needs, the exclusion applies regardless of whether the employee has qualified adoption expenses. (Code Sec. 137(a); Code Sec. 137(b); Code Sec. 137(f)) The excludable amount is phased out for taxpayers with adjusted gross income (AGI, as specially computed) over a threshold amount. (Code Sec. 137(b)(2), Code Sec. 137(f)) For tax years beginning in 2013, the phase-out range is $194,580 to $234,580. Review Question 7 In 2013, an employee receives $14,000 of adoption assistance from her employer in connection with her adoption of a child with special needs. The employee s AGI for 2013 is $100,000. She incurs a total of $6,000 of qualified expenses in connection with the adoption. How much of the adoption assistance is excludable from the employee s income for 2013? a. $14,000. b. $12,970. c. $6,000. d. $0. 9. Fringe Benefits Fringe benefits received by an employee are taxable unless specifically excluded. A fringe benefit isn t included in gross income if it s excluded under a specific Code Section (e.g., education assistance, group term life insurance; see above) (Code Sec. 61(a)), or it qualifies as one of the following: (Code Sec. 132(a)): No additional cost service. These are services provided by an employer to an employee for personal use by the employee, his spouse or dependent children, if (1) the services are ordinarily offered for sale to nonemployee customers in the ordinary course of the line of business in which the employee works, (2) the employer incurs no substantial additional cost (including foregone revenue) in providing the services to the employee computed without regard to any amounts paid by the employee for the services (Code Sec. 132(b)), and (3) special nondiscrimination rules are satisfied. (Code Sec. 132(j)(1)) Qualified employee discount. A qualified employee discount is an employee discount allowed with respect to qualified property or services provided by an employer to an employee, his spouse or dependent children, to the extent the discount doesn t exceed certain limits. The excludable amount of a qualified employee discount for property is limited to the gross profit percentage of the price at which that property is offered by the employer to customers. (Code Sec. 132(c)(1)(A)) The excludable amount for services is limited to 20% of the price at which the employer offers the service to nonemployee customers. (Code Sec. 132(c)(1)(B); Code Sec. 132(k)) 9